When we look at the broader activity in the financial markets over the last few months, it would be hard to call stock activity anything but bullish. Newer investors who missed the initial moves are wondering whether it is too late to start buying into the major stock benchmarks.
Primary examples include the SPDR S&P 500 ETF (SPY, Financial) and the SPDR Dow Jones Industrial Average ETF (DIA, Financial). But the latest trends have managed to influence even more diversified sectors with the tech-heavy PowerShares NASDAQ Trust (QQQ, Financial) pressing ahead to new highs.
The fact these rallies have been widespread is significant because it is a much better foundation for the stock space as a whole. But all bull moves come to an end at some stage, and the fact we saw tremendous difficulty in the Dow in its attempt to vault the key psychological level at 20,000 is a testament to that.
Investors who are looking to avoid losses should proceed with some level of caution here in order to prevent themselves from entering into long positions at elevated levels.
Market Factors
One of the main factors here is the growing likelihood the Federal Reserve will need to start raising interest rates faster than previously expected. This has led to higher volumes in forex trading when investors are looking to express position stances in major currency pairs like the EUR/USD and USD/JPY.
Several sales metrics have shown we are already seeing changes in the level of inflationary pressure that is present at the consumer level. If this continues, the Fed might be forced to prepare the broader economy for more rate hikes. Whether this will ultimately impact corporate earnings remains to be seen.
Chart: PowerShares NASDAQ Trust
External market indicators like the iPath S&P 500 VIX ST Futures ETN (VXX, Financial) are still trading at long-term lows, which has led many analysts to question the possibility of shorter-term declines going forward. This trend direction has already started to develop in the PowerShares DB US Dollar Index Bullish (UUP, Financial), but there are generally different forces at work when we are comparing what is happening in currencies rather than stock markets.
Trading Strategies
With all of this in mind, it makes sense to consider some alternative investment strategies. Options positions could limit the potential for downside if investors start reacting negatively to potential interest rate hikes. Investors who believe the Federal Reserve will need to add interest rate hikes this year could consider put options at current levels as profits would be generated by any selloff declines inspired by those taking profits while valuations are still high.
Overall, the slowing momentum in stocks could lead to profit-taking rather quickly if the Federal Reserve commentaries suggest a need for higher interest rates. This has been one of the biggest obstacles standing in the way of new highs in the equities benchmarks.
Disclosure: The author has no position in any asset mentioned.
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